OREANDA-NEWS. May 30, 2013. In line with our predictions, ALROSA managed to finish year 2012 with strong financial and operational results. Business margins of ALROSA remained largely unchanged at high levels. Indeed, the operating margin in USD terms stood at 33%, EBITDA margin was 40%, while the net margin increased to 22% from 19% a year before, on the back of lower financial costs and smaller losses from FX translations.

The long-term drivers of ALROSA remain largely the same: the rise of demand for diamonds from developing countries, which underpins price growth, higher quality and quantity of diamond output on the back of more extensive underground mining, as well as the possible desire of the company to participate in JVs focused on exploration and mining of diamonds.

We have updated our valuation model of ALROSA to incorporate the increase in diamond production after consolidation of OJSC Nizhne-Lenskoye, as well as minor adjustments to our estimates of future costs.

In early 2013, a subsidiary of ALROSA acquired a 51% stake in a diamond miner Nizhne-Lenskoye OJSC with the annual diamond output of about 1.7-2 mln carats. In our opinion, this acquisition will have a positive impact on the operating and the financial performance of the company in the long term and may prove one of the major drivers for the company’s stock. However, investments will inevitably increase. Indeed, we have previously suggested that the annual CAPEX of ALROSA would stand at about \\$700-800 mln, but the consolidation of Nizhne-Lenskoye, as well as the investments in natural gas assets, which the company plans to sell in the future, have inflated the annual CAPEX forecast to \\$800-900 mln, and this is not the limit.

ALROSA plans to reflect the results of Nizhne-Lenskoye in its financial statements for 2013. In view of this, we have revised our valuation model of ALROSA shares and the financial forecasts for the company. We now expect that in 2013, the volume of diamond production and sales will amount to about 36.21 mln carats, while the average selling prices of industry- and jewelry-grade diamonds will rise by respective 3% and 5%. In view of the projected growth of sales prices and volumes, we have increased the company’s revenue forecast for 2013 by 6% from our previous estimate.

That said, we had to cut our projections of EBITDA and net income due to higher expectations about operating costs and interest expenses. The former forecast has been cut by 4%, the latter - by 14%.

In 2013, we believe, the total debt of ALROSA will remain at USD4 bln, translating into Total debt/EBITDA ratio of about 1.89x, versus 2.06x in 2012.

Our assessment of the key risks pertaining to the shares of ALROSA remains unchanged: we point out possible growth of production costs due to the transition from exploiting alluvial deposits to underground mining. In 2012, the cost of diamond production stood at \\$69.64 per carat, which is above the level of 2011 by 12%.

Risks of higher debt burden on the company's business also remain in place. Although ALROSA, according to our estimates, should be able to maintain the long-term Total debt/EBITDA ratio at about 2, we believe that possible further acquisitions, participation in JVs and other factors may significantly affect the growth of CAPEX and the amount of the company’s debt.

In our view, the key value growth driver of ALROSA during 2013 will be the planned sale of a 14% stake in the company (7% are presently in the federal coffers and another 7% are held by the Republic of Yakutia) in the course of privatization. ALROSA is a unique company in its sector, occupying a key position in the diamond market and having significant market power (about 30% of global production). Because of this, we believe that the company may be interesting to a wide range of investors. The most value-accretive scenario for the company would be offering its shares to a large number of market participants, which may have a positive impact on the overall liquidity of its stock.

We have updated our target price of ALROSA shares, increasing it from \\$1.06 to \\$1.22 per share, but affirmed the BUY recommendation. The TP upgrade has mainly been caused by the decrease of the discount rate and the extension of the forecasting horizon. Based on this estimate, the target price of ALROSA shares is 20.73% above the current market level.